Thursday, August 13, 2009

Putting an Economics Degree to Work

Robert Mugabe, President (Dictator?) of Zimbabwe does not suffer from a shortage of education. In the 1950s, 60s and 70s he earned no less than seven degrees. These are not honorary degrees of which he has many, though some have since been revoked.

Mugabe has three Bachelors degrees, in Economics, Education, and History and Literature. While imprisoned for 11 years from 1963 to 1974 he completed four degrees by correspondence which were awarded by the University of London. He gained a Masters degrees in Economics, a Bachelors degree in Administration as well as two Law degrees.

Thus with two Economics degrees including a Masters one would expect that Mugabe would have a grasp of basic economic concepts. One example should be enough to question the value of these degrees.

Question: What is the solution to rampant inflation?
Mugabe: Print more money and introduce price controls.

Here is a stunning image that brilliantly illustrates that Mugabe has little understanding of the role of property rights and the effect of The Tragedy of the Commons on economic outcomes. This image gives an aerial view of farmland in Zimbabwe.

The Centre for Global Development provides a handy interactive tool using this and other images. They also provide the following analysis which gives a nice pointer on causality.

Land reform begun in Zimbabwe in 2000 was supposed to redistribute land from predominantly white-owned commercial farms to much poorer black farmers who toiled on communal lands. Proponents argued that the redistribution was necessary because commercial farms occupied the most fertile lands, leaving only dry, dusty land for communal use. This rationale reflects confusion about cause and effect regarding land ownership and land quality. In the "Before" photo below, the dry communal lands on the left are sharply delineated from the green private farms dotted with lakes and ponds on the right--so sharply that soil quality and rainfall are unlikely to explain the difference. Now click the arrow to see what happened after land reform. The dams and irrigation systems on the private farms collapsed, making them look more like communal lands, to the detriment of all.

This is not the only aerial image that shows the power on institutions in determining economic outcomes. Check out this night time image of the Korean peninsula.

Finally there is the suggestion that it is not the fault of Robert Mugabe and other failed economists that they have such a poor understanding of the subject. The Economic Naturalist , Robert Frank in a 2005 New York Times column wrote the following:

Virtually all economists consider opportunity cost a central concept. Yet a recent study by Paul J. Ferraro and Laura O. Taylor of Georgia State University suggests that most professional economists may not really understand it. At the 2005 annual meetings of the American Economic Association, the researchers asked almost 200 professional economists to answer this question:

"You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50."

The opportunity cost of seeing Clapton is the total value of everything you must sacrifice to attend his concert - namely, the value to you of attending the Dylan concert. That value is $10 - the difference between the $50 that seeing his concert would be worth to you and the $40 you would have to pay for a ticket. So the unambiguously correct answer to the question is $10. Yet only 21.6 percent of the professional economists surveyed chose that answer, a smaller percentage than if they had chosen randomly.

When they posed their original question to a large group of college students, the researchers found that exposure to introductory economics instruction was strikingly counterproductive. Among those who had taken a course in economics, only 7.4 percent answered correctly, compared with 17.2 percent of those who had never taken one.
Maybe Mugabe would be better able to deal with Zimbabwe's hyper-inflation if he'd never taken an Economics degree!

Wednesday, August 12, 2009

Hot dog, anyone?

Here is a very interesting article about a failed hot-dog vendor in New York. He missed rent payments on his license to sell hot-dogs from a cart on the steps outside the Metropolitan Museum of Art. What's so interesting about this? Well his annual rent was $642,696!!!

Hot dog heartache has come to the Metropolitan Museum of Art, where the Parks Department on Friday evicted a weiner vendor who couldn't pay his $53,558 monthly rent.

The frankfurter failure is Pasang Sherpa, 51, of Long Island City, who agreed late last year to pay almost $643,000 annually for the right to sell food and drinks from carts on either side of the iconic steps. He fell $310,000 behind on rent and the city has seized $170,000 in Sherpa's assets.

A worker at one of the carts who was hanging up his tongs Friday night said it brought in just $1,000 to $1,500 a day - not enough to cover the sky-high rent. Sherpa was the highest bidder last year when the Parks Department auctioned the right to sell hot dogs there. It is the most lucrative spot in the city, in front of one of New York's top tourist attractions with no nearby stores or restaurants.

The same paper reports that Sherpa got a job from one of his fellow cart operators, Dan Rossi, and notes their problems with unlicensed vendors.

"He's gonna work for me now," said Rossi. "Nobody's gonna touch him now without talking to me."

"The guy was crying. They pushed him out," Rossi said.

"Yeah, I'll work for him now," Sherpa said yesterday. "It's better than nothing."

"Last night I couldn't sleep," he said. "I've got kids who have to go to college. I don't know what I'm going to do."

Sherpa and Rossi say the city needs to do a better job keeping so called "black market" hot dog vendors away from the Met. "As soon as they pulled Sherpa's cart out yesterday, all these guys just pulled in. The city has to enforce the law," said Rossi.

These unlicensed dealers offer dogs and drinks for less money than the legit businessmen, whose prices are set by the Parks Department. "I sell water for $2 and the others sell it for $1," he said. "If I charged $10 a hot dog maybe I could compete."

Back in January The New York Post reported the agreement that Sherpa would be selling hot dogs at $2 dollars each. That's almost 320,000 unit sales just to cover the rent cost. To put it into perspective consider the comparison to the number of minutes in a year - 525,600. To cover the rent Sherpa needs to sell "one hot dog every 1.6 minutes — and not just during lunch or other normal meal times. Rather, it is assuming Mr. Sherpa (or someone else working for him, presumably for pay) is manning the cart 24 hours a day.

In the same article The Post also reports that altough Sherpa had won the auction to the rights to both the South and North sides of the entrance steps he had paid more than €80,000 for the Northside rights even though there is a little more than 30 yards between them!! The combined rent from the auction for the previous year before rookie Sherpa entered the fray was $415,000.

Hot Dog Cart News (who?) are obviously a cheerleader to the industry and suggest that this may not have been such a crazy deal:

How many hot dogs, chips, and sodas do you need to sell just to break even? Let’s do the math:

Keep in mind this is a premium tourist destination and there is no where else to eat. I’m guessing that a dog, chips and soda would sell for $8. If so, Sherpa needs to serve 80,338 meals to break even. That’s less than 2% of the 5 million folks who walk right by his carts on the way in or out of the Met each year. Granted he has other overhead to cover, but nothing even close to those rent payments. If he sells to just 10% of the tourists he will gross…

Four million dollars a year. I’m getting dizzy.

This analysis is full of holes. What about the capital, labour and materials costs that would be incurred in order to sell the 80,338 meals to cover the rent? The rent is only an element of the fixed costs. The carts, staff and hot dogs do not come free and form part of the variable costs. It is these that determine the break even level. So how did our hero get into trouble? Hot Dog Cart News have the answer:

But here’s a lesson. Before you sign anything, make sure all your ducks are in a row. Only one of Sherpa’s carts passed the health department inspection, and his coveted north entrance will be blocked by construction for months. Again, holy #$&* ! Wouldn’t you have done a little more due diligence before jumping into the big leagues? So now he doesn’t want to pay. Big surprise.

This little case study provides material and examples for a plethora of economic concepts:

  • economic rent, super-normal profits and rent seeking
  • consumer surplus and producer surplus
  • defining, allocating and the value of property rights
  • market structure and barriers to entry
  • fixed and variable costs
  • the short run and long run shutdown decisions
  • ad rem(per unit) versus lump-sum (fixed) charges
  • risk and uncertainty
  • effects of regulation and the value of licenses
  • allocative (in)efficiency of a planned economy
  • competition ($1 water) versus monopoly ($2 water)

and probably most evidently of all

  • auctions and the winner's curse

Tim Harford, in The Undercover Economist, analyses a similar example when it looks at coffee shops, their location and the price of a cappuccino in the first section of the opening chapter which is called "Who Pays for Your Coffee?". You can read the first few pages from this chapter here.